"We're looking reality in the face and it isn't pretty," said Bank of Israel Governor Stanley Fischer at a special press conference convened yesterday, following his aggressive interest-rate cut. Although Fischer on Monday lowered the overnight central bank rate for February to a historic low of 1%, Michael Sarel, a leading economist, suspects another cut could be in the offing.

"It's not pretty, but we can cope," Fischer told the press conference.

Alongside the grim picture of the state of the global economy, Fischer had another message: "What happens here depends on the global economy, but also on ourselves - the Bank of Israel, the Finance Ministry, the private sector, and anyone responsible for the economy's development."

But most importantly, much depends on U.S. president Barack Obama: Rebound here also depends on him, Fischer said. If the U.S. starts to rally by mid-year, economic growth here could resume in the second half of 2009.

But if the American recovery tarries and global recovery is delayed, Israel's recuperation won't begin before 2010, Fischer said.

Israel's banks are in relatively good shape, compared with their peers elsewhere, Fischer repeated. That doesn't mean they don't face hard times, and with the economy projected to contract by 0.2% this year, they face mounting problem debt as their clients default.

This is something that the banks will have to cope with, Fischer said. Yet at this stage, he added, local banks are not at risk.

Make no mistake, the Bank of Israel will be keeping a beady eye on them, ensuring that they maintain satisfactory levels of capital adequacy, and a 12% minimal ratio of capital to customer loans.

That level of capital adequacy is not high, Fischer said - but it is necessary.

The 20 largest banks in the world have lost 72%-94% of their equity over the past year, Fischer noted. The situation was far less dire in Israel: 61% of Bank Discount's equity was wiped out, 59% of Bank Hapoalim's, Bank Leumi lost 48% of its equity, First International lost 52%, and Mizrahi Tefahot lost 35%.

Yet the public's deposits at the banks are not at risk, Fischer stressed.

"The finance minister has made a specific promise on this matter, and I assume that the entire government will stand behind this promise," Fischer said yesterday.

During the last quarter of 2008, the global economy, and Israel's too, went into free-fall, Fischer said. The American economy contracted by 0.5%, and Singapore's plummeted by 16%.

In this respect, he said, Israel's situation is far better: Economic growth is zero, but that's better than contraction.

Israeli households are in better financial shape than American ones, the governor said. Israelis took fewer loans, because they are more conservative consumers.

Meanwhile, even though Israeli interest rates have never sunk this low, economist Michael Sarel thinks they could drop more.

The Bank of Israel's next move depends to a great extent on the dollar-shekel exchange rate, said Sarel, who heads the economics and research department of Harel Insurance and Finance: If the shekel weakens against the dollar, the central bank won't cut the rate any more.

But if the exchange rates stays at about NIS 4 to the dollar, the BOI could lower its overnight rate to banks by half a percent, to 0.5%, he said.

"Even an interest rate of close to zero percent is no reason to halt the rate cuts," added Sarel.

The Bank of Israel cut the interest rate by 0.75% to 1% Monday. It also lowered its economic growth forecast for 2009, which had been 1.5%, to just minus 0.2%.

Unemployment is expected to average 7.6% in 2009, compared to 7% as predicted earlier.

"According to one school of thought, rate cuts are less effective than they have been in the past, because of the credit crisis, and therefore, the rates should not be further cut. This school of thought is incomprehensible. Interest rates should be lowered more sharply precisely because the action has a weaker effect on economic growth." Sarel argues.

Cutting interest is supposed to stimulate the economy, and could result in inflation. But there is no such dilemma in this case, Sarel says: Inflation forecasts are currently at below the central bank's target range of price stability, which is 1% to 3%.

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